Did You Make an IRA Withdrawal Last Year?

The nice thing about an Individual Retirement Account (IRA) is that money you put into it is tax deductible and the earnings are tax deferred. But when you withdraw money from the account, that's when you have to settle up with the Internal Revenue Service (IRS).

With a rocky economy the last four years, some people have had to make withdrawals from their retirement accounts just to pay the bills. If you made a withdrawal last year, you need to determine how it's going to affect your tax bill.

IRA rules

If you are older than 59½, the amount of your withdrawal is added to your ordinary income. As far as the IRS is concerned, it's money you earned last year. The only tax implication is however much the withdrawal adds to your income, and whether it raises you tax rate. Otherwise, you pay the tax at the same rate as other income.

For example, if your loss of income drops you into the 15 percent tax rate, you'll pay 15 percent of your withdrawal in taxes.

Possible penalty

If you were not yet 59½ last year, you may be looking at an early withdrawal penalty in addition to a tax as ordinary income. Generally, early withdrawal from an IRA prior to age 59½ is subject to being included in gross income plus a 10 percent additional tax penalty.

However, there are exceptions that could save you from the penalty. One of the exceptions is using IRA funds to pay your medical insurance premium after a job loss, a situation many found themselves in last year.

Also, if you made an IRA contribution last year – perhaps before losing your job – you are allowed to withdraw it penalty-free, if you do so before the date you next tax return is due – in this case April 17, 2012. Obviously, if you withdraw your contribution, you can't claim it as a deduction on your return.